Michigan VC ‘very healthy’ despite decline in out-of-state capital

In securing a $40 million investment, Cirius Therapeutics Inc. illustrates a fundamental change that occurred in Michigan’s venture capital sector over the last decade.

Namely, funds active in the state now have a greater ability to syndicate deals for startups that require larger investment rounds.

As startups that were seeded years ago progress toward commercialization and require more capital, early financial backers say they’re better able today to partner with firms from outside of Michigan.

“Michigan has made great strides,” said Mark Olesnavage, managing director of venture capital firm Hopen Life Science Ventures in Grand Rapids and incoming chairman of the Michigan Venture Capital Association. “Michigan does get more attention, clearly, than it got years ago.”

The Cirius Therapeutics deal involved Frazier Healthcare Partners in Seattle, Wash., Novo A/S and Chicago-based Adams Street Partners, plus Renaissance Venture Capital Fund in Ann Arbor. They joined with Hopen Life Science for the $40 million round in Cirius Therapeutics. A spinout from Kalamazoo-based Metabolic Solutions Development Co., Cirius is developing a potential treatment for non-alcoholic fatty liver disease.

The greater ability of Michigan-based funds to pull in outside investment partners for larger, later-stage deals comes despite three fewer out-of-state venture capital firms having an office in the state at the end of 2016. Cambridge, Mass.-based Flagship Ventures, Open Prairie Ventures in Effingham, Ill., and Cleveland, Ohio-based Early Stage Partners each closed their Michigan office after deploying their capital.

The net result was an overall decline in the amount of total venture capital under management in Michigan to $4.02 billion in 2016 from $5.26 billion the year before, according to the MVCA’s annual research report. Out-of-state capital under management alone declined to $1.62 billion from $3.04 billion, but remains well above pre-2013 levels.

In-state capital under management grew 8.5 percent last year to $2.4 billion. That’s twice the amount of in-state capital under management from just six years earlier and about triple compared to a decade ago, according to the MVCA annual report.

“The Michigan venture community is still very healthy,” Olesnavage said.

He and others expect it to stay that way.

Ninety-four percent of the firms operating in Michigan told the MVCA they believe the investment and entrepreneurial climate in the state has stayed the same or improved in the last three years. Of Michigan venture capital firms now fundraising or planning to raise money for a new fund in the next three years, 85 percent are confident of success.

Ten firms operating in Michigan are presently fundraising and collectively have an average targeted fund size of $65 million, according to the MVCA report.

“Overall, I’m optimistic” about venture capital in Michigan, said Chris Rizik, a partner and founder of Renaissance Venture Fund in Ann Arbor that invests in other funds in Michigan and the U.S.

Firms and venture capital professionals who have helped to build the sector in Michigan over the last decade and a half need to sustain their efforts to keep it growing, Rizik said.

“We’re certainly in the best shape I can ever remember us being in, but it is always precarious,” said Rizik, who notes the state now gets much more attention nationally from larger funds based elsewhere.

ATTRACTING ATTENTION

Of the 25 funds across the nation in which Renaissance Venture Fund has invested, 60 percent had never previously done a deal in Michigan, Rizik said. Nearly all have since invested in the state or are close to doing a deal, he said.

“We have more funds around the country looking at Michigan than I have ever seen before. Whether they have offices here or not, they’re still coming around and looking and that’s the most important thing,” he said. “The number of firms that are coming regularly to Michigan and are regularly looking at deals is the best it’s been. And every time we have a success, that makes it even more likely that out-of-state funds are going to come in here and look, because they want to look at places they can make money and find good deals.”

The Cirius Therapeutics deal is one of those successes that can help to draw more attention to Michigan, Olesnavage said.

“Larger rounds from larger players do help,” Olesnavage said.

DEAL FLOW DIPS

The average amount of capital under management for Michigan-based firms grew in 2016 to $96 million, up from $88 million the prior year. The average fund size increased to $50 million from $45 million in 2015.

Michigan-based venture capital firms invested $222 million last year in 54 startup companies. However, that was below the $282 million put into 74 companies in 2015. The decline in deal flow was likely the result of a normal investment cycle and follows a decline nationally in the amount invested and the number of startups that received funding, said MVCA Executive Director Maureen Miller Brosnan.

Last year also included the largest VC deal ever in Michigan: a $62 million investment in Ann Arbor-based Millendo Therapeutics Inc.

“We’ve seen this pattern evolve from 2011 to 2016 and expect that, as Michigan’s entrepreneurial and investment community matures, the ebbs and flows will be less dramatic,” according to the MVCA research report.

‘NORMAL TURNOVER’

Over a five-year period, the number of active Michigan companies backed by venture capital grew 48 percent to 141. During the same time, the number of venture capital professionals working and investing in the state was up 41 percent.

The number of venture capital firms based in the state grew 25 percent, total capital under management increased 60 percent, and startups receiving funding grew 42 percent over a five-year period.

Venture capital firms have about $424 million available for follow-on investments in existing portfolio companies in Michigan. That’s up 10 percent from a year earlier, but short of the estimated $504 million demand in the next few years.

Despite last year’s dip in out-of-state firms with offices here, the industry “is holding pretty steady” in the total number of venture capital firms operating in Michigan, Miller Brosnan said.

“That’s just churn and the normal turnover of business,” she said. “The fact that we’re able to remain steady like that tells me we’ve built a really strong investment community here in the state and that we’re here to stay.”